The Freddie Mac T-Series wrap: A service or disservice to mortgage-related ABS?

GSE involvement in the wrapping of subprime mortgage- and home-equity loan-backed asset-backed securities is viewed by some as an encroachment beyond the bounds of the agencies' Congressional charters, which bear an implicit guarantee from the U.S. government.

But Freddie Mac, on the other hand, views its limited participation as an insurer of mortgage-related ABS as helping to create standards in a sector of the market where business practices, such as predatory lending, threaten all involved.

"As part of a general thrust into non-agency capital markets, Freddie Mac is obligated to offer this program," said Richard Cooperstein, vice president for structured transactions for Freddie Mac. "As part of our mission we provide financing in housing markets for average income Americans and liquidity for these loans in secondary markets."

The standards Freddie is trying to set deal primarily with predatory lending practices, namely requirement of loan servicers to report to credit repositories on a regular basis, as well as Freddie's refusal to purchase loans with front-loaded credit insurance premiums or prepayment penalties past the fifth year of the loan.

T series wrap

Freddie Mac's "T series" surety wrap is used to guarantee offerings backed by collateral originated by independent lenders that would not conform to Freddie's PC Gold standards. For example, a Freddie Mac T-33 wrap was used to guarantee a class of sub-prime mortgage-backed offerings from the Lehman Brothers issuance vehicle Amortizing Residential Collateral Trust (ARC). The $335 million A1 class, with a 3.2-year average life, priced with a coupon of 11 basis points over one-month Libor, 13 basis points tighter than the comparable $104.3 million A2 class.

The ARC Trust deal, series T-33, is the 33rd ABS deal Freddie has guaranteed since the program's inception in 1997. The T-series was expanded to include home-equity loan collateral in 1999.

The spread differential, according to Cooperstein, illustrates the value that investors place on the added security and liquidity a T-series wrap adds to a security. Cooperstein compared the concession to the one placed on a Jumbo RMBS versus PC Gold.

"The fact that investors are willing to accept a lower yield on T-series securities, I think, relates to Freddie Mac's financial strength and the liquidity a Freddie Mac wrap adds to a security," Cooperstein added.

A friend or foe to monolines?

It is a well known fact that many in the mortgage market are fearful that the GSEs have overstepped the bounds set forth by its Congressional charter, although few will go on record with such feelings.

"If any independent originators are fearful, they misunderstand our role," Cooperstein counters, noting that originators are Freddie Mac's customers and that all stand to benefit from the increased standardization that results from GSE participation.

As for the insurers, such as AMBAC, FGIC and MBIA, competitive fears do not enter into their mindset. "We do view their activity as competition but since these are deals that we would likely pass on, we view them as good competition," said a source at a bond insurer.

Cooperstein concurs, adding that Freddie looks at the rival bond insurers more as partners than competitors, saying "they (insurers) help distribute all this risk throughout the market."

But the bottom line in all of this is that, in Freddie Mac's eyes, this program helps Americans with more modest incomes obtain conforming loans.

"Our mission and our obligation, in addition to adding liquidity to housing markets, is to help finance housing for Americans with average incomes, putting an end to high-cost lending." said Cooperstein.

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